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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
Welcome to the TCW Investment Perspectives Podcast, where our investment
professionals put current events into context and share their
insights and expertise on how to make the most of your portfolio.
Today, we're digging into the global energy transformation and how investors can
access this trend, including some pockets of opportunity that may be surprising.
I'm David Vick, I'll be your host today.
Joining me today are Eli Horton, Managing Director and Equity
Portfolio Manager of our Energy Transition Strategy here at TCW,
and Valeria Mendiola, one of our Equity Portfolio Specialists.
Welcome, both of you.
Thanks for having us.
Great to be here.
Great to be here, Dave.
Energy transformation has become a popular topic over the last couple of years.
Eli, can you start out just by giving us kind of the lay of the
land, telling us what this energy transformation is all about?
Maybe what it means for sort of the bigger picture?
Absolutely.
I think the energy transformation is an incredibly exciting topic.
It's funny that you said it's become even more topic over the past couple of
years, because I'd actually take a step back and say, if you think about our
energy system, we have been on this migration away from fossil
fuels towards renewables for probably a couple decades now.
But we're still in the very, very early innings of that transformation.
And to your point, that is making this transformation more topical by the day.
I like to measure the progress that we've made just by
looking at how we produce the power by which our world runs.
And just in the United States, less than 20% of our
power is generated from renewable sources, with the
rest of it, over 80% being sourced from hydrocarbons.
We're nowhere close to completing the transformation of our energy system.
And I would say it probably takes several decades from here.
It's very, very expensive.
The world's investing on the order of $2 trillion
currently to migrate towards a renewable energy system.
And that investment is only growing by the year, I think
it reaches over $5 trillion by the end of the decade.
So an incredible amount of change, huge dollars,
structural trend or early innings, which makes all of this
extremely interesting from an investor's perspective.
Obviously, with the new Trump administration in a bunch of changes,
uncertainty, especially with regards to power generation, obviously,
they've backed out of the climate accord, growing pushback against ESG.
How does that relate to this?
And is it still sort of relevant?
And is it still an important topic moving
forward from here with the new administration?
I can jump in here with this one.
But that definitely the Trump administration and ESG has been on the
headlines for several weeks now, I think first, I want to highlight
that the energy transformation is not an ESG topic,
our demand is growing, whether we like it or not.
And we can touch later on the specifics of what's driving that growing demand.
But all the current and future administrations actually have
to focus on what is the best way of making sure that we
actually are able to have enough power for future demand.
And I think most people and the political discussion in particular,
is mostly focused on the power generation component of it.
So where are we sourcing the energy from?
Are we using nuclear power, renewables, etc.
And I think to us, the energy transformation is way more complex than that.
It's basically a combination of systems that have to work
perfectly well together in an efficient way to ensure
that we have enough power for the near future.
And that's going to require really a mix
of all of these different types of energy.
So you make a great point, the consumption of
energy, power, electricity is structurally growing.
And we have this challenge and imperative of becoming more
efficient with how we produce and consume that power.
And we need to migrate towards more and more renewable resources to do so.
This is not a question of ESG, this is really an economic imperative.
And I call it a non-discretionary change a lot.
If you go back, I threw out some numbers earlier, it's
about $2 trillion of capital that's being invested to
transform the energy system that powers our economy.
Of that $2 trillion, when we cut through the
numbers, over two thirds of it is privately funded.
It's not just supported by government stimulus.
These are real economic issues and needs that companies are
investing in, that consumers are requiring of companies.
And it's a, like I say, it is a non-discretionary,
significantly large investment.
Well, you both have touched on something that I
think is worth digging into a little bit more.
You both mentioned that electricity demand has continued to go up.
And with the electrification of the automotive fleet,
AI demands, the expectations is that will continue.
But what's your sort of longer term perspectives on the demand for power?
And how does that compare to history?
And what should we be thinking about going forward?
Yeah, I mean, that's completely right.
I think we can dive into the specifics of how much we
think energy demand and power demand is going to grow.
But basically, power demand has been flat for the past 20 years, right.
And then we like to highlight three key things that are
happening in the markets that are driving that power demand.
The first one is, we have these AI megatrend.
Power is a big component of that megatrend.
So there is a lot of debate in terms of how much more power will be needed
to train artificial intelligence models and into having data centers.
I think there are a lot of estimates, but basically, electricity
demand from data centers is expected to grow significantly
through the decades representing around 8% of the US electricity
consumption by the end of the decade versus 2.5% today.
And so what we do know for certain there is
that there is more power capacity needed.
And the second item that we always like to highlight is
there's a lot of there's this trend of supply chain reshoring,
and we want to bring back manufacturing into the US.
And so there are currently over $1 trillion getting invested
to be able to bring back these manufacturing capabilities.
And so manufacturing and power go hand in hand, right?
You cannot become a manufacturing superpower
if you don't have enough electricity for that.
And then the third thing that I would highlight is the
electrification of everything in the economy, right?
If we look back just to a couple decades ago, there are a lot of things that
we take for granted right now that were just not in existence back there.
We didn't have electric vehicles, we didn't have power stoves, for example.
And so these technologies have made electricity consumption a more pressing
issue, especially for grids that are just not designed for this level of demand.
I think it's worth double clicking on some of those things.
Valeria gave some really good stats, but the need for more power and for
grid reinvestment is something we've been studying for a few years now.
And it's become more topical of late.
But the problems were already brewing underneath the surface.
So the remanufacturing or the reshoring of
manufacturing is a very important point here.
So every 1% change in imports increases US electricity demand by 10%.
That's significant.
The EVs are another very significant driver of greater electricity need.
And currently we're at 8% electric vehicle penetration.
That's going to move significantly higher and will
require much greater power draws from the grid.
Then you look at the current infrastructure of grid assets, the average high
voltage transformer is 40 years old, the transmission lines are a similar age.
We have starved the grid for investment in a very long time.
And that chronic cyclical underinvestment just at the time that you have
reshoring, electrification, and now the need for greater electricity for compute
for AI, that secular need, that chronic cyclical underinvestment is creating a
very nasty collision course, and rapid change in an old economy industry that
would have historically been thought as very sleepy when you
think about utilities or, or independent power producers.
So there's a ton of change taking place.
We're investors, we look for that kind of change.
It's really an optimal setup for us.
And I want to highlight that all of these kind of sub themes, megatrends,
they are really not dependent on the administration that is in power.
These are transformations that are happening in
the economy, regardless of any politics happening.
Got it.
So we know there's going to be growing demand for electricity.
But there are lots of ways to generate electricity, right?
There's renewables, gas, coal, nuclear, all sorts of things.
So can you walk us through some of the prospects for some
of those different generation techniques and anything else
out there that we should be thinking about at the moment?
So at the end of the day, we need more power and
electricity, and we need it from all sources.
But not all these sources are created equal.
And if you think back over the past handful of
years, there has been a very, very aggressive push.
And it's been supported by, by policies and by tax
credits, very aggressive push towards wind and solar.
And we think these are very critical components of the equation.
But on their own, they're insufficient to
power our economy, our economy runs 24/7.
And the sources of power are intermittent, you
need the wind to blow, you need the sun to shine.
And somehow, in these recent years, we've neglected very
important sources of power from nuclear and natural gas.
And we think there's tremendous opportunity there.
I'll start with nuclear, the US has only built
a few nuclear reactors since the year 2000.
We have around 95 nuclear reactors today.
And there are no new large scale nuclear reactors planning to be built.
This is a very valuable source of power.
And you can see this in certain agreements that the hyperscalers have
made take Amazon and Microsoft, the announcement from Microsoft to
reopen Three Mile Island was fascinating just on the headline basis.
But just in the past year, the prevailing price of nuclear
power has gone from 35 bucks a megawatt hour to close to
$140 a megawatt hour based on that Three Mile Island deal.
And why is that it's because it's 24/7 and
it's carbon free, it's incredibly valuable.
Similarly, natural gas had sort of been left for dead for many, many years.
And we are very much of the view that natural gas
is a critical component of powering our economy.
If you look from the year 2000 to 2015, the natural gas turbine
shipments were averaging around 60 gigawatts go to 2023.
And that number had been cut in half.
Now we're seeing natural gas turbine orders doubling year over year
again, we need this reliable baseload 24/7 power, or the needs of
electrification, or manufacturing plants and for AI data centers.
And you know, just I think the key takeaway from this is that in the
end, we're going to need a mix of all of these different technologies.
But also, you know, even when we think about the mix of
technologies, we did some analysis internally at TCW.
And basically, we realized that when we look at an AI data center, for
example, it probably needs around one gigawatts of power to function.
And so solar panels, for example, can generate
today around 15 watts per square foot.
So if we wanted to power a one gigawatt data center
for AI purposes, we would require around 1500 acres.
So it's really also a real estate issue.
Like we can't just rely on one specific technology as a source of energy.
Actually, let me stop you there, Valeria.
That's an interesting point.
So I know that solar panels have gotten far more
efficient today than they were 10 or 15 years ago.
And so presumably, that means that the land required
will be less today than it would have been years ago.
How does that sort of the impact of advancing technology potentially impact the
demand for power or for for anything else as we go through this transition?
Yeah, you know, that's actually a very good point.
I think if technology has taught us something is that as more
advances happen, it just becomes cheaper to build capabilities.
And that for certain applies for the solar panel situation, for example, I'm
sure that the cost of solar right now, and the amount of real estate that they
take is very different versus what it was 20 years ago, right, which also on
the positive side means that it allows for more players to enter the market.
Well, I think we can step back and almost think about human ingenuity
and advancements in technology as a mental model for a variety of
things that are driving increased power and electricity demand.
So we outlined three dynamics that are driving power
consumption, one electrification of everything to restore
to manufacturing three demand for compute for AI.
So first, electric vehicles, why are electric vehicles proliferating?
Well, certainly one of the reasons is that we continue to drive
down battery costs and battery costs have fallen by over 90%.
That is only going to continue to fall further.
And it tips the cost equation closer and closer to parity and
eventually in favor of EVs versus ICE vehicles, which is a great
value to the consumer, and accelerates electricity demand.
Second one was manufacturing and bringing it back to the US.
A key enabler of that is automation, robotics, vision, factory automation
inside of these facilities to drive down each incremental unit of output.
Third driver of power consumption would be compute for AI.
We we look at compute as a measure of a system's
ability to perform calculations, process information.
And this is another area where we see some very gaudy numbers,
hundreds of billions of dollars of CAPEX being spent on AI to
build some of these models and look for other applications.
And it's our expectation that we will see meaningful decreases in cost
per unit of compute in the out years and in the in the coming years.
What will that do?
It should if you look at history as a guide, it
should actually increase the demand for compute.
It should increase the demand for the resource, which
only adds to the draw for power and electricity.
And so that was a lot but I think human ingenuity and
innovation is a very important driver of this theme.
I think the other important takeaway here is not just on the businesses
themselves, but taking a zoom out, just thinking about the stocks, we've
been talking about all these old economy, industrial and energy companies.
And I don't think it's a first order thought to look at those
sectors and say, wow, there's a lot of change taking place.
We tend to think about change in the technology sector.
But we are seeing such a new emergence of leaders.
And what I would say is a regime shift taking place and systems
change in these old economy industries, which as active managers
and stock pickers, creates really fertile hunting grounds for us.
Well, that's a great segue to the next question, which is,
so as an investor, like, what should you be thinking about?
What are some opportunities that we've identified that are available today?
Maybe some things that your average investor might not associate
with energy transformation and things happening today.
It's funny that we use the term energy transition.
But I think just that name in and of itself
really oversimplifies what's taking place.
The systems that underpin how our world is
powered, it's not just the energy itself.
It's the industrial equipment, it's the
materials, it's certain commercial services.
So many different industries and systems have to function
in a coordinated fashion for us to accomplish this
huge structural change in how our world is powered.
We manage an energy transition strategy.
When we go and segment the universe, it is far
greater and wider than just energy companies.
We are looking at industries such as aerospace, where just
commercial air travel generates significant amount of emissions.
And we are seeing meaningful innovation on the engine side to drive
greater efficiency, not just in emissions, but it brings down the cost
of fuel for the airlines, which can then be passed through to consumers.
We're seeing businesses in the waste management industry, take their landfills
and through some really clever ingenuity and ideas have taken the landfills
and captured gas from biodegradable material, basically methane, but they can
process that methane and turn it into renewable natural gas
and sell it back into the industry just to power our world.
That is an energy transition investment in and of itself.
And so we see this in a variety of industries, but no one typically
thinks of aerospace or waste, which are just two examples.
When you say energy transition.
I totally agree with Eli's point.
And you know, I think one of the biggest mistakes that investors
make is they only invest, they hear energy transition and they
only invest in an energy index or like a utilities index.
If you look at the market, market returns for the past, say, 20
years, the overall market returns have been around two times
higher than the returns of the energy sector by itself.
And that just tells you a lot about this energy transformation,
this energy transition, which is more beyond the energy
sector by itself or the utilities sector by itself.
And again, I know past returns are not guarantee of future returns, but
it's just it tells it paints a very clear picture of how the systems work.
All right.
Interesting food for thought.
Thank you guys.
Appreciate it very much.
Thanks for taking the time to speak with me.
I'm sure we'll be talking with you again, since these are
issues and investment opportunities that probably aren't
going to go away, they'll be with us for a while.
For more information on TCW strategies, please visit our website at tcw.com.
Thanks for listening.
We'll pick up next time exploring the trends
and opportunities shaping global markets.
Thank you for joining us today on TCW Investment Insights.
For more insights from TCW, please visit tcw.com/insights.
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